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April 12, 2007

CVC withdrawal unlikely to end Sainsbury’s speculation

The private equity consortium looking to take over UK retailer Sainsbury’s withdrew its offer yesterday (11 April) after failing to win over family shareholders. But, writes Katy Humphries, speculation regarding the retailer’s future is unlikely to go away.

The private equity consortium looking to take over UK retailer Sainsbury’s withdrew its offer yesterday (11 April) after failing to win over family shareholders. But, writes Katy Humphries, speculation regarding the retailer’s future is unlikely to go away.

The news yesterday (11 April) that CVC Capital Partners had dropped its GBP10.1bn (US$19.7bn) takeover bid for the UK retailer Sainsbury’s in the face of opposition from the Sainsbury family, the company’s largest shareholder, and pension trustees has brought a long-running saga to a close. But it is unlikely to end discussion both in the media and investment circles regarding the retailer’s future.

Arguably of most interest to investors and observers will be how the retailer uses its substantial property portfolio, which had been one of the sticking-points in talks between the family shareholders and the bidding consortium.

In particular, the decision by property tycoon Robert Tchenguiz to raise his stake in Sainsbury’s has focused attention on the question of the retailer’s real estate. Tchenguiz has stated publicly that he believes the company can gain greater value for its shareholders by better use of its property portfolio.

The Tchenguiz Trust has in recent weeks raised its stake in Sainsbury’s to 4.68%, and yesterday Tchenguiz reportedly indicated his intention to up pressure on the supermarket group to extract value from the freehold and long leasehold properties that it has on its books. “We’re happy with our investment for the time being. Obviously, part of our investment decision is because they have got a good property portfolio,” Tchenguiz said.

Indeed, the value contained in the property portfolio has arguably held up the retailer’s share price following yesterday’s news. Since the beginning of February, when it was revealed that private equity groups were circling the retailer, Sainsbury’s shares have skyrocketed, reaching a high of 568 pence at the beginning of this week (10 April) when takeover talk was at its height.

Following yesterday’s announcement, shares in the retailer fell, dropping to 520.50 pence by lunchtime today, but this is still 14.4% higher than when the saga began, indicating a growing expectation for increased shareholder returns.

There is clearly continuing hope among investors that the group will unlock some of the value in its property portfolio, estimated to be worth about GBP8bn.  However, while there is mounting pressure to increase returns, such a move would have some significant pitfalls.

Analysts have pointed out that Sainsbury’s is not in a position to make a big capital return and continue to operate easily because it has no free cash flow to speak of. Meanwhile, although margins are gradually improving at Sainsbury’s, they are still coming in below those of the market leader Tesco.

In order to maintain a competitive edge, the UK’s third largest grocer, which is two years into a three-year recovery plan devised by chief executive Justin King, must strive to keep a tight lid on overheads. To leverage the value of its freehold property is to add risk to the balance sheet, opening the retailer up to rising future costs and competitive pressures.

In a note to investors this morning, ABN Amro downgraded Sainsbury from ‘hold’ to ‘sell’ based on these concerns. Analysts at the investment firm said that it does not view a significant property release as possible without harming operational and financial flexibility. Likewise, Seymour Pierce rates Sainsbury’s stock as ‘sell’, with a target price of GBP4.20.

Sainsbury’s told just-food that it has not yet come to any decision regarding the possibility of unlocking the value of its property portfolio. “If and when a decision is reached with regard to any actions to increase returns above and beyond the recovery programme, through a property sale or other means, we will publicise them,” a spokesperson for the retailer said.

However, it was clear that concerns over the way the private equity consortium, comprising CVC, Blackstone and TPG, may have used the property portfolio was one of the factors which dissuaded the Sainsbury family, which controls 18% of the company, from backing the bid.

While differences between the bidders and the pension trustees also threatened to compromise the deal, intractable opposition from the family shareholder group made a successful bid impossible. As Seymour Pierce analyst Richard Ratner pointed out: “The Sainsbury family own an 18% stake. You can’t make people sell their shares unless you hold over 90% of a company’s stock.”

After the collapse of the bid, Lord Sainsbury, the group’s former chief executive, elaborated on his reservations in a statement. “I do not, and never have, objected to any bid in principle but emphasise that I would only support one that I believe would make the business better and stronger,” he said.

According to Lord Sainsbury, a strong balance sheet and freehold property base have been central to the retailer’s success. If the bid had been successful, the private equity groups had planned to unlock the value of Sainsbury’s property portfolio. “Eroding these attributes will make the company more vulnerable to competitive pressures, which is not in the best long-term interest of the company, its customers, its staff, its shareholders or its pensioners,” Lord Sainsbury wrote.

How that analysis may be reconciled with the views of investors such as Tchenguiz remains to be seen. The uncertainty created by a potential takeover bid may have been lifted, but it seems that in an atmosphere of increasing investor activism there could well be some troubled waters ahead for Sainsbury’s.

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